Definition / Scope

In July 2015 Greece stands at a crossroad of choosing between moving with the failed macroeconomic adjustment programs imposed by the creditors or working a real change to break the chains of debt. Five years since the economic adjustment and bailout programs began, the country remains deeply rooted in economic, social, democratic and ecological crisis.

Greece’s economy has underwent severe recession since the debt crisis began in 2010. Two international bailout programmes in 2010 and 2012 provided a total of around €240 billion (£171 billion) as financial aid to Greece with stringent conditions designed to reduce the budget deficit and improve economic recovery. Against this backdrop of economy being in continued severe economic and social pain, the left-wing Syriza party, won the January 2015 election beating the incumbent centre-right New Democracy party.

Market Overview

Greece is probably insolvent. Reducing its debt can take years of large primary surpluses and these would require great spending cuts. Greece has an incentive to default to start running surpluses

There was risk that contagion might lead to crises in Portugal, Ireland, Italy and Spain. However, the situation in Greece stands far worse than that in these economies.

GDP growth is projected to be positive and to pick up in 2016, but there is the possibility of an associated deterioration in financing conditions. If these uncertainties can be contained, then the economy can recover in 2015, driven by exports, private consumption and business investment.

Key Metrics

Metrics

Value

Explanation

Base Year

2016

Researched through internet

Market Risks

Since mid-1990s, Greece was spending more than it was collecting in tax revenues. The country’s initially reported numbers that showed small differences but were subsequently found to have been much greater as found by new governments after elections. In order to cover these deficits, the country borrowed, thus raising its debt burden steadily.

The newly elected government in 2009 reported that the deficit for the year will stand close to 13.6 percent of economic output and that the deficits in 2007
and 2006 were also under-reported. With this scenario, the world began to wonder if Greece really had the capacity to pay its debts or shall there be default on its part? Thus, its borrowing costs rose sharply and the country felt the need to reduce its required debt payments.

Economic Depression

The economic recession started in 2008 led to fall in GDP by over 25% till 2014, when growth finally returned. This led to steep fall in living standards and social conditions. The unemployment rate raised from 8% in 2008 to 28% in middle of 2013, which slightly became 26% in December 2014. The unemployment rose to 60% in 2013 which was at 50% in early 2015.

The number of working people fell by 1 million, which is a decline of 20% of the employed population. Wages also declined resulting in increase in poverty. The 3/5th of the people are not satisfied with the life they are leading and the 3/4th people are living in bad household situation. During first 3 quarters of 2014 the GDP has shown some signs of stability and the Greek government was able to sell bonds having periodicity for five years to the investors.

Bailout in 2010

By 2010 the excessive debt problem became unbearable and there were speculation that Greece would default, as it had done on four occasions previously since 1800. Most debt was owed to banks outside of Greece, with the largest being to France and Germany, hence posing threat for substantial losses. Greece was granted a bailout in 2010, but as held by Karl Otto Pohl, former head of the German central bank, much of the money was used to repay the borrowings of the French and German banks.

Thus, Greek could avoid default as new lending came as a rescue for Greece, but there was an urgent need to reduce the chronic deficit spending. Greece did cut their deficits substantially, but many reforms that would have supported growth did nottake place and the economy suffered contraction. Moreover,no debts were written-off during 2010.

Bailout in 2012

By late 2010 it became clear that the debt burden was unsustainable, thus to reduce debt ,the Greek government was supposed raise money by selling some assets, which never happened and as the recession continued, thus it became clear that the 2010 plan was not adequate. Thus,a second bailout program with revised terms was undertaken in March 2012. The IMF lent new money with similar conditions that accompanied the funding made earlier, with emphasis on making the tax collection more efficient, reducing spending promises, and undertaking reforms to encourage hiring and business expansion to support growth.

The European Central Bank meanwhile became more deeply concerned to stabilize financial markets. ECB President Mario Draghi said in July 2012 that “within our mandate, the ECB is ready to do whatever it takes to preserve the euro. And believe me, it will be enough.” This statement immediately led to a drop in borrowing costs across Europe and the pressure on Greece subsided temporarily. The ECB also created conditions to support the trading of Greek debt. By this time, the German and French banks had shed their exposure to Greece.

Recent Upheaval

Since Draghi’s statement, there were three substantial progress in Greece. First, on closing its deficits, by late 2014, Greece’s spending finally reduced than it’s revenue collection, although there was still an overall deficit. Hence, for the first time since adopting the euro it had a solid budget position. Second, the economy seemed to have contracted and finally began recovering in late 2014.

The third major development was that the public lost faith in the government and its lenders. Unemployment in Greece remained above 25% for years and there was anguish among the people which showed up in the elections held in 2015, wherein a new government was elected that insisted on deviating from the past playbook. A new coalition was formed, with major party being Syriza, often referred to a coalition of the radical left. January 2015, saw reopening of negotiations with Greece’s creditors, under the leadership of newly elected Prime Minister Alexis Tsipras.

The Tsipras government focused on three types of changes. First, to restore some of the spending cuts that were enacted. Second, to reverse certain revenue hikes that past governments had initiated. These steps would have widened the deficit and reorganized priorities within the budget.

Finally, it wanted outright forgiveness for certain accumulated debts. Since taking office, Tsipras has been negotiating for a new set of agreements with the creditors, with not much success except few concessions. When he failed to secure these changes, Tsipras went for the Greek people vote on a referendum on July 6th 2015 over whether Greece would vote yes to accept the creditors latest offer or vote no to reject it. Tsipras argued that the public should reject the plans, but he says that he will go with the public if they prefer to accept them. Greece has recently announced that it will not pay the IMF the €1.55 billion that it owed on Tuesday (June 30); but interestingly, Greece did make a small payment to the European bailout fund, so it will not be in default.

The ECB decided no more extraordinary lending will be extended as Greece might not honor the obligations. However, the ECB has not completely cut off its support to Greece. Greece closed its banks so that depositors cannot withdraw all of their money. Limits are imposed on withdrawal from ATMs and on wire transfers. This has created fury among the investors. Now some economists believe that Greece should have defaulted in 2010 as its debt burden then was unsustainable and the money that was raised to pay off the creditors in that bailout could have been diverted to support Greece and other weak countries.

Debt Levels Revealed (2010)

The European statistics agency, Eurostat, had regularly visited Athens since 2004 with a view to improve the reliability of statistical figures related to the Greek national account, but to no avail. In January 2010, a damning report was issued which contained accusations of falsified data due to political interference. With coming of the new government of George Papandreou, in February 2010, it was admitted that a flawed statistical procedure existed, before the election of the new government and revised the 2009 deficit from 6%–8% to an alarming 12.7% of GDP.

In April 2010, the reported deficit further increased to 13.6%, with final revised calculation setting it at 15.7% of GDP; it being the highest deficit for any EU country in 2009.

Towards the end of 2009, the figure for Greek government debt was also revised from €269.3 billion (113% of GDP) to €299.7 billion (130% of GDP). Publication of flawed estimates and statistics in 2009 by Greek authorities led to Eurostat deciding to perform their own in depth Financial Audit of the fiscal years 2006–09. After conducting the financial audit, Eurostat noted in November 2010 that all the “methodological issues" were now fixed, and that the new revised figures for 2006–2009 could be considered reliable.

In January 2010, despite the crisis, the Greek government's bond auction offered amount of €8 bn 5-year bonds which was over-subscribed by four times. Again in March, it was reported by The Financial Times "Athens sold €5bn in 10-year bonds and received orders for three times that amount". But this continued success of auction and sale of bonds was only possible at the cost of increased yields, which in return caused further worsening of the Greek public deficit.

As a result, the Greek economy was downgraded to junk status by the rating agencies in late April 2010. This led to a freezing of the private capital market, requiring international bailout loans to avoid a sovereign default to cover for the Greek financial needs. It was also realized that up to 70% of Greek government bonds were held by foreign investors, primarily banks. The subsequent bailout loans paid to Greece were mainly utilized to pay for the maturing bonds and to finance the continued yearly budget deficits.

Greek Banking System under Pressure

The IMF estimated in June 2014 that 40% of all loans provided by Greek banks at the end of 2013 were non-performing. Greek banks also held a large quantity of Greek government bonds.

Greek banks reliant on funding from the ECB and Deposit outflows accelerating

Greek banks are dependent on funds from the European Central Bank. The ECB stopped accepting Greek Bonds from 4th of February this year as collateral against funds, but it still provides a lifeline to Greek banks through its Emergency Liquidity Assistance (ELA) programme, which is for solvent banks and intend to be temporary. ELA funding need to be approved by 2/3rd of the ECB Governing Council for any change The ECB raised the cap on ELA funding to Greece from €60 billion to €86 billion by 19th June. The increase in funds is needed for Greek banks to replace an outflow of customer deposits.
The banks in Greek have shown fall of 19%, in the five months December 14 to April 2015 which is its lowest level in more than a decade. In case ELA funds prove insufficient, Greece would likely need to impose capital controls to limit the amount of money being withdrawn from banks. Failure to extend the current bailout programme would probably result in Greece defaulting on at least some of its debt. If this happens the ECB may decide to either to reduce or to end ELA, which may result Greek Banks becoming insolvent. In view of this ECB is keeping a close watch on the bailout programme.

Upcoming Debt Repayments

Until a final list of reform proposals is approved by the institutions – the EC, IMF and the ECB – there won’t be any distribution of bailout funds to Greece. Greece hasn’t received any bailout programme since August 2014 and is not able to access international financial markets to borrow more money, thus raising serious questions about its ability to pay its debts. Greece needs to repay the ECB €3.5 billion on 20 July and €3.2 billion on 20 August for expiring Greek bonds the ECB holds.

Other Possible Solutions

One of the solutions would be a deal that would allow a third bailout fund to be made to Greece. Another could be for the ECB to lift the limits it has placed on the Greek government to issues short-term government debt and on Greek banks to hold it. Lifting these limits shall allow banks to purchase newly-issued government debt, providing the government more flexibility to make its debt repayments. However, the ECB is reluctant for this as it might break its rules against financing governments through the monetary policy. The option of borrowing some money from the Eurozone bailout fund set aside to stabilize Greek banks, that is the Hellenic Financial Stabilisation Fund.

References

Greek debt crisis:background and developments in 2015, Number 7114, 6 July 2015, By Daniel Harari

Bank of Greece Website

Wikipedia: Domestic Bank lending-credit in Greece since 1980

The Greek sovereign debt crisis and the Eurosystem, DIRECTORATE GENERAL FOR INTERNAL POLICIES, by Prof. Anne Sibert, Birbeck, University of London and CEPR